The ratio of sales to inventory, inventory turnover, can paint a picture of how well a company's merchandise is selling. It represents the number of times a retailer sells and replaces its inventory during a given period. While both very high and low inventory turnover ratios can be bad for business, investors need to consider the industry's average inventory turnover ratio to evaluate what a reasonable inventory turnover ratio looks like.

How does inventory turnover compare at these retailers?Inventory levels can vary greatly due to seasonal demand, such as during the back-to-school and holiday season. Persistently low inventory turnover can signal a lack of consumer interest in a retailer's merchandise. A high turnover is desirable, as long as the retailer can keep up with the demand for its products and avoid merchandise shortages. The following tables show the evolving story of how Abercrombie, Aeropostale, and H&M managed their inventory assets during the last four years.

Abercrombie's inventory turnover ratio has lagged the industry average for the last four years. Surprisingly, it's not that much different than that of H&M, which is also averaging a three-day turnaround. Abercrombie has a market cap of $2.5 billion and operates about 1,000 stores. It is much smaller than H&M, which has a market cap of $70 billion and operates about 3,000 stores. However, Abercrombie's average inventory has been trending upward, while its cost of goods sold and gross margin have been trending lower since 2010 or 2011 -- two signs of declining sales. Part of the reason for the squeeze on gross margin is the sale of merchandise at discounted prices.

In comparison, Aeropostale's inventory turnover is quite high, well above the industry average. This is usually a good sign, but in this retailer's case it may indicate problems with inventory control. Aeropostale's steep drop in gross margin -- an almost 50% decrease since 2010 -- tells the real story here. This should be worrisome for investors, even as the company secured a loan and security agreement in May 2014 to avoid a liquidity crisis.

Aeropostale

FY 2013

FY 2012

FY 2011

FY 2010

Cost of Goods Sold (b)

$1.687

$1.764

$1.709

$1.514

Avg. Inventory (m)

$164

$159

$160

$145

Inventory Turnover

10.3

11.1

10.7

10.4

Gross Margin

17.1%

24.7%

26%

36.9%

Industry inventory turnover

4.2

3.6

4.3

4.3

Source: ARO Fundamentals

H&M, along with its other fast-fashion counterparts, has had better results in attracting the teen market with its lower-priced merchandise. The Swedish-based retailer has an inventory turnover just below the industry benchmark for women's apparel stores. However, its lean average inventory levels are more closely aligned with its net sales, especially in comparison with Aeropostale and Abercrombie. In its 2013 financial report, the company stated that its inventory, or stock-in-trade, balance reported was higher than normal due to the company's expansion plans. So as it's stocking up on merchandise in anticipation of more store openings amid a challenging retail environment, investors should see this as a positive sign of growth.

H&M Hennes & Mauritz AB

FY 2013

FY 2012

FY 2011

FY 2010

Cost of Goods Sold (m)

$7.93

(SEK 52.5)

$7.28

(SEK 48.9)

$6.38

(SEK 43.9)

$5.79

(SEK 40.2)

Avg. Inventory (stock-in-trade-m)

$2.40

(SEK 15.9)

$2.16

(SEK 14.5)

$1.85

(SEK 12.7)

$1.57

(SEK 10.9)

Inventory Turnover

3.3

3.4

3.5

3.7

Industry inventory turnover benchmark

4.2

3.6

4.3

4.3

Gross Margin

59.1%

59.5%

60.1%

62.9%

Source: HMRZF Financial Reports ;

My Foolish conclusionWhile it's important for investors to look at a variety of metrics when selecting companies for investment, inventory turnover can reveal a lot about how quickly a retailer is selling its merchandise. A high or low turnover ratio can also reveal problems in other areas of the business, such as inventory management, marketing, and purchasing. Of the three companies mentioned, Abercrombie and H&M seem to have better handles on moving their sales inventories. It's likely that sales of heavily discounted merchandise will continue at Abercrombie for the next few quarters, which will negatively impact gross margin and may impact shares.

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Interesting article. Retailers have to manage their inventories efficiently and make sure there is sufficient stock available at all times to ensure the timely delivery of products and services to consumers. A viable operations strategy with sophisticated technology within the business and embracing best practice approaches can improve margins and increase customer service metrics. I work for McGladrey and there's a whitepaper on our website that offers good information on the above that readers will find helpful @ http://bit.ly/1kgYXWo